The face of the gaming industry is changing.
The gaming industry is an alliance between the channel providers and the content providers. Both areas are facing change.
The Channel Providers
Both Google Inc (NASDAQ:GOOG) and Amazon.com, Inc. (NASDAQ:AMZN) recently launched game stores as part of their app stores. Apple Inc. (NASDAQ:AAPL) has had one for a few years, and it already has over 100 million members.
Google is continuing its practice of challenging Apple on its home turf, and trying to further monetize its Android users, while Amazon is following a similar strategy with its version of Android. If the Apple Inc. (NASDAQ:AAPL) example is any indication, both of these companies have the potential for a great deal of growth in these stores. Because Android users cannot use Apple’s store (and Apple Inc. (NASDAQ:AAPL) users can’t use Android stores) Apple’s store and Google Inc (NASDAQ:GOOG)‘s store are not direct competitors. Most users do not choose what ecosystem to join based simply upon the gaming options available. Thus, in the case of Google Inc (NASDAQ:GOOG), since Android is larger than iOS, I think Google’s store will likely grow even larger than Apple, to a couple hundred million.
This does not tell the entire story by any means, for the gaming industry is an alliance between the channel providers and the content providers.
The consumers’ gaming device may be changing, but the types of games that they want to play is not. As a side note, the industry has become increasingly hit-driven. Some games such as Call of Duty® are phenomenally successful, while many others languish and never earn a profit. In other words, the gaming industry is becoming more like the pharmaceutical industry or like Hollywood in that the majority of products lose money, but a few become phenomenally successful. This raises the level of risk in the industry. The firms need hits, or they cease to be profitable.
The Content Providers
This evolution has clear implications for the two main content providers: Activision Blizzard, Inc. (NASDAQ:ATVI) and Electronic Arts Inc. (NASDAQ:EA).
Both of these companies have been weathering the storm well. Activision Blizzard, Inc. (NASDAQ:ATVI) is up by about 40% this after falling about 10% last year, and Electronic Arts Inc. (NASDAQ:EA) is up by about 60% this year after falling about 30% last year (Yahoo Finance).
Activision Blizzard
Activision Blizzard, Inc. (NASDAQ:ATVI)’s two main avenues of revenue are its massive-multiplier role-playing online games (MMORPGs); and several franchises of video games. Many of these games continue to be highly successful and have high margins. However, here is precisely where one of the its major difficulties lies. None of the franchises are particularly new, and several are declining. World of Warcraft ® is the largest MMORPG with 8.3 million subscribers, but it shed over a million users over the last several months (Activision Blizzard).
Activision Blizzard, Inc. (NASDAQ:ATVI) exceeded expectations in the last quarter and is sitting on over 4 billion in cash (Activision Blizzard). Essentially, the firm is in something of a holding pattern; it is doing well monetizing past successes, but its investor’s guidance does not push any new franchises, focusing on further installments of already successful franchises. The most notable success story comes in its digital department — its revenues are 14% year-over-year with margins of over 50% (Activision Blizzard).
Electronic Arts
Electronic Arts Inc. (NASDAQ:EA)’ results are similar.
It is continuing to launch the newest iterations of a number of successful games, with a plan to release 11 major titles in FY2014 (EA). It also intends to launch 15 titles for iOS and Android. It has significant cash about $1.68 Billion, about 1/4 of the share price, about the same percentage as Activision Blizzard, Inc. (NASDAQ:ATVI).
Electronic Arts Inc. (NASDAQ:EA)’s gross margins are quite healthy at 74.4% in the fourth quarter, resulting in net revenue of $1.209 billion overall and net digital revenue of $453 million. Its most notable success is that for the first time in its 31 year history, it expects to be able to weather a hardware transition with flat costs but increased revenues. It intends to increase profits conservatively by streamlining the business with less of a focus on aggressively expanding its business through increased intellectual property and geographic expansion (EA).
Not All Doom and Gloom
Activision Blizzard, Inc. (NASDAQ:ATVI) and Electronic Arts Inc. (NASDAQ:EA) have two main potential upsides to this mobile transition. First, the gaming industry goes through hardware updates every couple of years. Thus, these companies have acquired a great deal of experience weathering the various transitions, and they have the cash balances to do so again. Unlike new entrants into the market, they know how to take a game and modify it so that it is still enjoyable and can be easily played on a new system. In the past, they had provided content to multiple different platforms and so have experience working and, in many cases, porting the games to the various platforms.
The other upside is even larger. The rise of smartphones causes significant reduction in revenues in the video gaming and PC gaming sectors. In the developed world, this means the net effect of increased mobile revenue to be severely muted. However, in the developing world such as India and China, video gaming and PC gaming had never achieved many sales in the first place. However, many places in the developing world are seeing vast increases in mobile use, thereby opening up huge new markets for content providers such as Activision Blizzard and Electronic Arts Inc. (NASDAQ:EA). Also, digital sales tend to have very high margins, suggesting a strong potential for increased profitability on the part of successful companies.
Risk
| Activision Blizzard | EA | |
| Betas | .71 | 1.04 |
The end story is simply that the rise of smartphones and tablets has severely disrupted the means by which consumers play games. This has large implications for both the providers of the mobile devices, such as Apple, and for the content providers.
Furthermore, the increasingly hit-driven nature of the industry has independently driven up the risk in the two companies. Although, neither of the companies Betas are very high, Activision Blizzard, Inc. (NASDAQ:ATVI)’s Beta is .71, while Electronic Arts Inc. (NASDAQ:EA)’s Beta is 1.04, the overall risk resulting from being in the industry is far higher. However, both companies are in a good position to handle that risk because of their large cash balances and history of making hardware transitions. Furthermore, because mobile opens up huge markets both in the developed world, and more importantly in places such as India and China. Therefore, these gaming companies are playing a riskier game with real potential for both loss and gain.
The article Gaming Companies Playing a Riskier Game originally appeared on Fool.com and is written by Paul Sangrey.
Paul Sangrey has no position in any stocks mentioned. The Motley Fool recommends Activision Blizzard, Amazon.com, Apple, and Google. The Motley Fool owns shares of Activision Blizzard, Amazon.com, Apple, and Google. Paul is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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